Bank Capital Regulation On Systemic Risk And Its Macroeconomic Impact Study

The recent financial crisis since2008has motivated researchers to reflect on thedrawback in the area of the financial regulatory policies. One important lesson of thecrisis is that micro-prudential supervision and capital regulation which is focused onsingle bank institution risk can not effectively safeguard the stability of the bankingsystem. Moreover inflation target monetary policy may not guard against systemicrisk and lead controversial topic in the research. Implementation of Basel III in2010has guide China bank capital regulation from focus on micro-financial risk to acombination of both macro-and micro-prudential regulation. In this circumstance howto measure the systemic risk contribution of bank institution in China, how to identifythe macro-system level of credit financing and cumulative risk, and how to build thecapital regulation tools based on systemic risk and measure the welfare loss that thenew regulatory capital regulation on macroeconomic volatility. And last how tobalance and coordinate this policy with monetary policy. All these important questionsare not only theoretical but practical issues and important to China’s financialregulation and macro-prudential policy framework design. It is also of significance tothe coordination of prudential capital policy and monetary policy in macro adjustmentprocess.In this context, from the point strengthening macro-prudential supervision, westudy the design and practical application of bank capital regulation based on systemicrisk, and its macroeconomic effects based on theoretical and empirical research. Thestructure of the study consists of three parts: the first part is to measure the banksystemic risk and design capital regulation. It includes two aspects according to thecross-sectional dimension and time dimension of systemic risk. On the one hand, westudy the evaluation framework for systemic important banks and the design ofsystemic capital surcharge, on the other hand we establish a macro-systemic riskindex framework for counter-cyclical capital regulation and study on the applicationand design of countercyclical regulation tools. The second part is a DSGE model to study the macroeconomic effect of the capital regulation which is based on systemicrisk. In a general equilibrium framework we measure the macroeconomic cost andwelfare effect of both increasing capital regulation and implementing countercyclicalcapital regulation. The third section is to discuss the trade-offs and coordinationproblems of optimal monetary policy and macro-prudential capital regulation, abouttheir relationship of the two policies as well as the effect under differentmacroeconomic circumstances. This paper is divided into the following aspects:1、we measure and rank the systemically important banks in China and build thecapital surcharge based on its systemic contribution. Considering the direct andindirect effect of risk contagion, we use both financial network analysis based onbalance sheet data, and CoVaR method based on market data to calculate the systemiccontribution and risk contagion effect of domestic banks. We also establish acomprehensive framework to evaluate63banks systemic risk contribution accordingto six types of indicators which include assets, system correlation, complexity,homogeneity and cross-border activity. Based on this calculation we divided the63banks into highly systemic banks, partial systemic banks, non-systemic large banks,and tiny banks. Our calculation provide quantitative basis for the capital surcharge ofsystemic banks.2. We study the pro-cyclical effect of bank capital in China’s banking industryand the corresponding design of counter-cyclical capital regulation framework.Counter-cyclical bank capital regulation is the core content of the macro-prudentialsupervision. However, it is a difficult problem about how to accurately determine theeconomic cycle and identify the characteristics, level and trend of macro systemicrisks, and also difficult about the timing and extent to implement counter-cyclicalregulation. Based on pro-cyclical effect analysis of our banking system, we build amulti-level and multi-dimensional macro-systemic risk framework to reflect thewhole credit level of our society and financial system, and also as indicator index forcounter-cyclical capital regulation. As for the identification of systemic risk status andits shift trend, the paper introduces Markov regime switching model to identify andanalyze the cycle and to determine the timing and extent of counter-cyclical capital provision. Our research provide the quantitative support for systemic riskidentification and counter-cyclical capital regulation.3. We establish a DSGE model which includes bank capital accelerator effect andfinancial accelerator effect to analyze the macroeconomic cost of capital regulationbased on systemic risk. By constructing a new Keynes DSGE model with bank capitaleffect and financial accelerator effect, we analyze the macroeconomic impact andinfluence of increasing regulatory capital and implementing countercyclical regulation.Our discuss is around three core issues: Firstly, what is the effect and mechanismabout the bank capital channel of the monetary policy transmission? Secondly, howare the shocks and influences to macroeconomic variables when increasing bankcapital regulation? Thirdly, whether the countercyclical capital regulation playing astabilizing role in real economic fluctuations. By theory and calibration analysis, wemake in-depth study about the role of bank capital to whole credit and the realeconomy, and provide theoretical and empirical study about how to implement bothmacro-prudential policy and monetary policy.4. Based on DSGE model we also study the relationship and coordination of bothmonetary policy and macro-prudential policy. In a unified framework we comparestress test results under different macroeconomic situation and compare the welfareloss under different combination of the two policies, so as to evaluate the sensitivityof policy parameters and its economic impact. Our in-depth study about therelationship between monetary policy and counter-cyclical capital is meaningful tounderstand the order, objective and economic effect of the two policies.5. We review US, Europe and UK etc bank regulatory reform acts, compare theirmacro-prudential framework and sum up reforms in systemic risk regulation. Wesuggest to improve macro-prudential supervision, strengthen systemic risk assessment,assure authorities’ regulatory responsibilities and tools, and value the coordinationbetween economy and finance sector and between monetary and macro-prudentialpolicy.As the financial crisis in not yet over, the identification measure and capitalregulation of bank systemic risk is still under discussion. There is large room for improvement in research data and methods. Moreover, the DSGE model we use issimple and can be improved in its complexity to accord with actual economy.Meanwhile, the research methodology and policy suggestion need to be tested inpractice.